• We favour domestic-focused businesses, given the relatively stable demand, and advocate a beta play strategy to track the global semiconductor run-up while being selective in the small-mid cap space. Sector earnings are expected to trend higher in 2H23 on short-term inventory replenishment and a seasonality effect, but a full-blown recovery remains distant. Valuation at c.+1.5SD from its 5-year mean has priced in the optimism, capped by elevated bond yields with a risk of derailed earnings. Keep NEUTRAL.

• Slow recovery. World Semiconductor Trade Statistics cut forecasts for the third time, lowering 2023F semiconductor growth by 7.5% to USD515.1bn (- 10.3% YoY), on more pronounced weakness seen in sensors and integrated circuits (IC) before a 11.8% recovery in 2024. Global Top 10 foundry will continue to see weakness into 2Q23 before a mild recovery in the 3Q23 peak season with persistently low capacity utilisation rates to carry through amid slow consumption. IDC noted that major OEMs point to a recovery being pushed further out and a weaker 2H. These were factored into the latest revision of 2023’s global smartphone shipments to a 3.2% decline from -1.1%.

• Worst is over? Given a seasonally stronger 2H for the technology sector, the market is now looking ahead, aggressively pricing high growth prospects into FY24F and potential new customer wins. Still, our ground checks and anecdotal evidence from the supply chain suggest that the upsurge is seasonal, and a slowdown may continue amid macroeconomic challenges. Major semiconductor giants Taiwan Semiconductor Manufacturing Co (TSMC; 2330 TT, NR) and lithography machine maker ASML (ASML NA, NR) have noted customers’ cautious tone and lack of mid-term order visibility.

• More downside to consensus. We believe there could be more downside to consensus estimates, given the expectation of the delay in recovery on top of cost escalation, especially staff and utility expenses, with the loss of economies of scale and elevated fixed costs following the various expansions done over the past two years. Based on consensus estimates, KLTEC is currently trading at 28.5x CY23F P/E and 22.4x CY24F P/E, on a 11.9% EPS contraction in CY23F before seeing a 25.6% growth in CY24F.

• Sector valuation is fair, given the uncertainty of a full-blown recovery – albeit offset by improved investor sentiment on potential new opportunities and clientele, and the Federal Funds Rate potentially peaking. Yet, we take a more cautious note given the sector’s current valuation. Some stocks are well- above the pre-pandemic level despite the overall higher interest rate and bond yields (Figure 8). Sector ESG scores are 2.9-3.3, with no major ESG risks.

• Top Picks: We like CTOS Digital for its domestic-focused business, leading position, and growth prospects in its various digital solutions and fintech. For the smaller cap space, we like Datasonic as we foresee sustained strong demand for its solutions in various national security projects and potential new project wins in its diversification strategy. For semiconductor exposure, we recommend beta play in Inari Amertron as a proxy to the industry, given its strong liquidity, as a big cap, and potential new clients from various ventures.

Source: RHB Research - 3 Aug 2023